Hello and welcome to the Australian Foundation
Investment Company Full Year Financial Results Briefing. At this time, all participants are in.
The listen-only mode.
There will be a presentation followed by a question and answer session. All questions will be taken via the webcast. If you would like to ask a question at that time, please enter the questions in the Ask a Question box at the bottom of the webcast window. I would now like to hand the presentation over to Mark Freeman, Managing Director of AFIC. Thank you. Please go ahead.
Good afternoon everyone. I'm Mark Freeman, the CEO and Managing Director of Australian Foundation Investment Company. Welcome to this full year result briefing. I'd like to begin by acknowledging the traditional owners and custodians from all the lands we are gathered on today and pay my respects to their elders, both past, present and emerging. Joining me today on this webinar, we have David Grace, Portfolio Manager for AFIC, and Winston Chong, the Assistant Portfolio Manager. Also, our CFO, Andrew Porter, our Company Secretary, Matthew Rowe, General Manager, Business Development, Geoff Driver, and Business Development Manager Suzanne Harding. This briefing is based on the material available on the company's website. Presentation slides will change automatically via the webcast. Finally, please note, following the presentation, there'll be time for questions and answers. We ask a question via the webcast using the tab at the bottom of the screen.
I'll now turn to Chart 2, which is our disclaimer, just to say we're here to talk about the company. We're not here to give any advice. Onto the next slide, just an overview of the agenda. I'll make some introductory comments. Then I'll pass over to our CFO Andrew Porter, who will talk through the results. Then David and Winston will talk through the markets and portfolio activity. I'll make a brief comment on where we are with International. I'll turn back to David for outlook comments and then we'll open up for questions. Moving to slide five, just to remind everyone a little bit about AFIC. We primarily invest in New Zealand and Australian companies, but as most of you are aware, we do have a small holding in international stocks, which is about 1.5% of the portfolio.
We are the largest listed investment company on the ASX with around 150,000 shareholders, with an independent board of directors. Importantly, the shareholders own the management rights to the portfolio. There's no external fund manager taking fees. The Management Expense Ratio, which is the cost of running the business, is around 0.16% at the moment and there's no performance fees with that. Those costs, I see those more aligned with the costs that you pay for an ETF in the market. Very low compared to most other managed products. We're fundamentally a long term investor. We want to be low turnover because we understand the drain that tax can have on performance. We'd like to have a portfolio and share price that's less volatile than the index. We do have a long history of stability in our dividends, which will grow over time.
The team also manages three other Djerriwarrh Investments, which is more income focused, Mirrabooka, which is more focused on mid to small cap stocks, and AMCIL, which is a high conviction fund. It means the team gets exposure right across the market from the very small to the largest companies. Just on the next slide, our objectives are to pay stable to growing dividends over time and provide attractive total returns again over that medium to longer term basis. We just put a very long term chart here on how the AFIC portfolio has performed against the index, just showing what AUD 10,000 would be turned. One of the things that I really note from that is the value of being invested in equities on an accumulation basis over the very long term.
Just on the next slide, just picking up the point about dividends, what we've done here is provide a bit of a history to show the dividends that you've received on your investment against the Earnings Per Share. We exclude one offs, so that's what he's saying. The income that we've been receiving on the portfolio, which is the yellow line, so you can see that COVID interrupted the flow of dividends. Dividends that we received or the income we received went down because companies we invested in cut their dividends. We were able to draw in our reserves of franking to sustain the dividend over time. More recently, as the operating earnings started to increase, we did increase the dividend. More recently, earnings have drifted a little bit. We've sustained the dividends and then importantly, as part of this result, we've paid.
We announced the payment of a special dividend of AUD 0.05 per share and we'll pick this up in the activity levels. As many of you know, we have been using the incredible valuation in CBA. A fantastic company, love everything about it. We struggle with the valuation and we've been taking a bit off the top. That's produced some realized capital gains and we've paid out some of the franking we've earned from that. These are special and there's still more within the company. I just want to pick up a point. Sometimes we have questions about growth in dividends. Clearly, if we had cut our dividend during COVID, we'd be showing very strong growth in dividends. When you sustain the dividend through the tough times, obviously you don't get that growth off a low point. It is really important to note the benefits of sustaining dividends.
You won't see the high growth numbers if you were to cut the dividends and then see it regrow again. The other thing to point out is the yellow line you can see has declined in the last two years. We are at the mercy of the markets. We invest in good quality companies, but our earnings are dependent on the dividends they pay out. Over the last year, you've seen the resource companies, which make up a big part of the dividend producing stocks in the market, their dividends are cut back. That means our dividends are cut back and the Earnings Per S hare go down. We're hoping that the whole market goes back to growth in dividends. That's the intent over time.
It just shows you that at the end of the day we've got to pay out what we can earn, and if we do have some excess Franking Credits through capital gains, we'll endeavor to get those back to shareholders and we've done that through the special dividend. We might get questions on that at the end, but we'll come back to that. As I said, we still have a lot of Franking Credits within the company that you're not seeing in the performance. It does give us plenty of capacity to think about sustained dividends if we go through another downturn. With that, I'll pass over to Andrew Porter, our CFO, to talk through the actual results.
Thank you, Mark, and good afternoon, ladies and gentlemen. Looking at the slide you've got there, which is four boxes, the profit for the year, AUD 285 million, slightly down on last year, AUD 296.4 million. As you saw from the slide that Mark had, the operating Earnings Per Share is now down 22.7%. Essentially back to where we were in 2019. Part of that has come through the sale of CBA and other bank shares, with obviously we are losing out on dividends from that. BHP and Rio, where we have been increasing our investment, they have also cut their dividends. Of course, because we've been investing, the total dividend return we got from those, the fall was not as much as it was from exiting some of those bank positions. The 10.7%, the portfolio return, that's including franking, that was below the market.
Details of all that are in the press release, and David and Winston will be going through some of that later on. Suffice to say, some of our good quality companies had a disappointing year in terms of share price returns, but we still believe that they are good investments for the long term. The dividend box at the top right, Mark touched on this. The ordinary dividend, this is the third year in a row that the ordinary dividend has increased, so that is pleasing for shareholders. As you said, this year we've also declared a AUD 0.05 special dividend. That's AUD 0.315 in total for the year, AUD 0.195 for shareholders this year. Interesting thing to note on that is this is all being paid out of capital gains. It has an LIC gain attached to it.
This means that those of you who do pay tax, whether personally or in your super fund, will be eligible for a deduction. Details will be on the website on the annual report, but check with your accountant or tax adviser if you've got any questions. Management Expense Ratio 0.16%. That's AUD 0.16 for every AUD 100 that you have invested. As Mark said, we believe that still represents very good value in terms of managed investments. It's slightly gone up this year. We continue to invest in the international portfolio. That's had some very good returns in and of itself. Also, as some of you are aware, we now have to start looking at sustainability reporting, which we'll have to do next year. That comes with costs attached in order to be able to do that.
Moving on to the next slide, slide 11, which is what we call the premium discount chart. Obviously, you as shareholders and us as executives and the Board are all very conscious of the discount that AFIC is trading at. Just to be clear, this is a market-wide problem for LICs. The Listed Investment Company Association is taking steps to market this. The vast majority of LICs are trading at a discount. What are we ourselves doing about that? We did have an on-market buyback program earlier this year. It was the first time we've done that for some years.
We're doing a lot of marketing activities ourselves because we are pointing out to shareholders, to potential shareholders, when there is a gap, when there is a discount that does represent good buying value, particularly with the dividends, the stability of dividends, and the special dividends as and when they come along. So, Mark.
Yes, just some of the other activity. I think we took a view previously about we have a DRP in place consistently, and I think we sort of, the term we use, we neutralize the dilution from that, and it's probably something that we could consider this time around again if we go to a very large discount. That's always open for discussion. We're doing a lot more, I guess, trying to understand and market to where we see potential investors. The market structure has probably changed a lot, or it has changed a lot probably over the last decade. We used to do a lot of our marketing really just through a couple of the brokers, but some of those have changed the way they operate. Financial planners have grown and developed, and some of those tend to use model portfolios, but there's still a whole lot out there.
They're looking to do something, I guess, a little bit different or look to see where they can find value in the market. I think we're starting to get some interesting traction. I mentioned Suzanne Harding. It's a recent appointment to us. Suzanne and Geoff have been out there trying to understand a bit more what's going on in the market and really try and rediscover who is interested in sort of getting exposure to the market through vehicles such as the LICs that are trading at such large discounts. Andrew pointed out it is something that's impacting the entire sector. Clearly, ETFs are having an impact, but the way we look at it is that ETFs, you're going to get, if you go into an ETF, you get the market at the current level. If you go into something like AFIC, you're getting market at a 10% discount.
You can choose when to buy it, and at the moment you can buy come dividend, come special dividend. The sustainability of dividends is important. Similar cost structure to an ETF. The whole sector has been through a bit of a phase where I think also a lot of retirees are sticking with fixed interest products. I think there have been some LICs that have been poor in terms of their execution. There are a lot of factors that have dragged on the sector, but we continue to see value there. We'll look to market it more. We don't like the fact that there is a gap. It's interesting. There was only a few years ago during COVID that we went to a huge premium.
A huge premium has gone to a huge discount, but you can see back to the slide, over the long term it does tend to trade closer to fair value. I know we're sort of getting a lot of questions on it. We'll continue to do what we can do to improve the profile of the funds, but in the meantime, there's no question that there's some value there against where the fair value sits in the NTA. Geoff, did you want to add anything to that?
No, I think you covered it pretty well, Mark.
I mean what you also find, I guess back to your comment about the LICs trading at discounts when the market runs very strongly, we tend to lag a little bit, and you can see on the other side that when the market's under pressure, both in terms of dividend payment but also as we had through COVID, we tend to go to a premium. Yeah, there's definitely a market cycle there. We're not happy with trading at a discount, such a large discount, and we're doing a lot of work presenting to financial advisors and brokers around the country, and we're starting to see some traction around that. That will take some time.
I think it is interesting that when you look at a few months ago when you had that brief market sell-off around the Trump tariff, obviously the market fell a lot very quickly, but the AFIC share price fell a relatively smaller amount, and so the gap closed substantially very quickly.
This gap about 7%.
Yeah. It showed that when you're in a tough market people could see the value in AFIC. I think a lot of people talking about that, that you can get exposure without perhaps the downside if there were to be a market pullback. At least that's what was witnessed a few months ago. We might move on from that and at this point we'll pass over to Dave and Winston to talk through the portfolios and markets.
Thanks Mark and good afternoon everybody. On slide 13, the chart on the left hand side shows the performance of the portfolio against the ASX 200 over various time periods. All portfolio and index return figures are grossed up for franking. For the AFIC portfolio, the returns only include the franking that AFIC has distributed to shareholders. As Andrew outlined earlier, we maintain a meaningful reserve of Franking Credits able to be distributed in future periods as we endeavor to maintain a stable to growing dividend over time. Portfolio returns are represented by the green bars and the ASX 200 returns. The purple, the one year performance has been disappointing with the portfolio returning 10.7% versus the ASX 200 return of 15.1%. On upcoming slides we'll outline the key drivers of this underperformance and our thoughts moving forward.
We consider the majority of the drivers to be temporary and in some instances recent share price weakness has provided the opportunity to add to some of our quality companies at attractive prices. The drag from the one year performance is clearly weighing on returns over longer time periods. As a reminder, our returns are reported after tax which was a significant drag on performance last year. However, the special dividend announced today of $0.05 per share fully franked is a partial return of the Franking Credits generated during the period, particularly as Mark mentioned, from reducing our holding in CBA. As previously disclosed, we are aware that the distribution of excess Franking Credits is highly valued by our shareholders. The chart on the right hand side splits market performance by sector over the last 12 months.
These numbers do not include franking and show the ASX 200 was up 13.8% during the period against the 15.1% shown on the left hand side. The best performing sectors were Financials and Communication Services. The Financial sector was driven by the strong performance of CBA which is up almost 50% in the last 12 months. Communication Services was driven by the performance of Telstra which increased 40% over the period. We added to our holding in Telstra earlier in the year, recognizing the company's outlook for accelerated earnings growth from both price increases and a more disciplined focus on costs. The largest underperformers towards the bottom of the chart were the Energy and Health Care sectors. The uncertain economic environment and increased production from many producers weighed on energy prices, while in the healthcare sector investor concerns centered around U.S. regulatory policy and likely tariff impacts.
These negative sentiments saw the share prices for both CSL and ResMed oversold in our view, and we added significantly to both these holdings. The long-term opportunity for both these companies remains significant, and both are well positioned to deliver strong earnings growth over the medium to long term. History shows that over the long term, companies that deliver meaningful earnings growth tend to do well. In a later slide, we'll talk to recent changes we have made to portfolio holdings. Onto the next slide. As earlier outlined, portfolio performance in 2025 was disappointing. A significant contributor was the portfolio holdings being overweight CSL, underweight CBA. We'll show you some charts on the following slides. While we believe our positioning in these companies will drive a better outcome going forward, the underperformance is not fully explained by our positioning in CBA and CSL.
What we've shown here on the slide are three areas that also contributed negatively to performance last year. The first bucket is stocks that we consider suffered from temporary cyclical headwinds. We don't consider that any of these businesses has been structurally impaired, and we have used the recent share price weakness to increase our holding in three of them, being ARB, CSL, and James Hardie. Both Reece and James Hardie have exposure to the U.S. residential construction market. The end market has been soft as the price for mortgages has remained high at a time when impending tariffs may make housing more expensive. In addition, Reece lost key employees to a new start-up competitor. The full impact of this remains to be determined. In the middle of the slide, we highlight IDP Education.
The company has seen a material deterioration in earnings as government policy settings have severely constrained international student mobility. In reaction, the share price fell sharply last year. This has been a painful reminder in the risk to any business model that is dependent upon favorable government policy. We've neither sold nor added to our holding at this stage. As we continue to review the investment case for this company, the last point on this slide just highlights that our minimal exposure to the gold and insurance sectors weighed on performance as both had strong years. Over the long term, both sectors have been notoriously cyclical with earnings driven by factors largely outside the control of the operating companies. For this reason, we believe our capital is better positioned in more attractive opportunities over our investment time horizon.
In terms of what did work, strong returns came from our holdings in JB Hi-Fi, Wesfarmers, Coles, Computershare, and Netwealth Group, with the share prices of all these companies significantly outperforming the index. Moving on to slide 15. The charts on this slide show historic earnings profile and share price performance for both CBA and CSL. I think they're a really useful depiction to explain current portfolio positioning, particularly sale and purchase activity in FY25 where we significantly reduced our holding in CBA and upweighted our holding in CSL. Charts go back to 2010, with the bars in each chart showing the company's annual Earnings Per Share, while the black lines track share price performance. History shows that over the long term, share prices typically track a company's earnings profile. With the exception of the COVID period, CBA has delivered consistent incremental earnings growth over many years.
What's unusual, however, is the rating the market is currently applying to that earnings profile. As I mentioned earlier, in FY25 the CBA share price was up 50%, far exceeding achieved earnings growth. CBA remains a well-managed, high-quality business, but at current pricing we expect investment returns to be reduced. CSL, on the other hand, develops therapies to treat chronic disease. Chronic meaning it's a long-lasting condition that generally cannot be cured and requires ongoing management. The earnings profile for CSL has been consistently strong as the bars on the right-hand chart show. However, as earlier outlined, CSL's share price has been under pressure, down almost 18% in FY25, materially underperforming the market.
We continue to believe the company remains very well positioned to deliver many years of double-digit earnings growth in its core markets, will continue to generate large free cash flow, and maintain a strong balance sheet well positioned to capture future growth opportunities. Charts on Slide 16 show a similar story of the valuation metrics between CBA and CSL. However, this time we have shown the earnings multiple of each stock and how they have trended over time. We've shown the price to earnings ratio for both companies over the last five years. CBA now trades at 29 times earnings, which compares to the five-year average of 20 times. While CSL is currently trading on 23 times earnings against its five-year average of 32 times. Even as long-term investors, the price you pay has a significant bearing on future investment returns.
We feel these charts are instructive in explaining current portfolio positioning. Moving on to Slide 17. The chart on this slide, which we've shown you before, just shows the valuation of the ASX 200 index as it stands today. What we've shown here is the price to earnings ratio over the last 20 years. Current level is 18.7 times, which is 28% above the 20-year historic average of 14.8 times. We know the performance of the market has been strong, however, the drivers of the recent strength have been pretty narrow. While any valuation chart doesn't tell the full story, it's still helpful to get a picture of investor sentiment towards equity markets, clearly highlighting that at a headline level the market today is very fully priced.
Our approach during these times is to capture buying opportunities in quality companies when temporary bad news leads to share price weakness despite the long-term opportunity being undiminished. At this point I'll hand over to Winston to talk through recent changes we've made to the portfolio.
Thanks Dave. Just on to slide 19. In managing the portfolio to achieve our key investment objectives, we're constantly looking for opportunities to add to our existing holdings or initiate new positions in quality companies with good prospects that are underappreciated by the market. Over the last six months we've used share price weakness in a number of our holdings to add to existing positions, as highlighted by the logos in the top left box of this slide. We participated in the Goodman Group capital raising in February, which serves to capitalize the company as it ramps up its data center strategy. Goodman has strategically located properties in capital cities around the world where demand-supply dynamics are strong.
As a result, we believe Goodman's planned pipeline of projects in these locations will generate good returns, and Goodman are using the capital raised to create a leading data center platform to serve growing cloud and AI demand in these cities. To capture this opportunity, given our growing confidence in this strategy, we also added further to our position in April as data center related stocks sold off. Along the same theme, we added to our position in NEXTDC as concerns around data center customers spending less impacted share prices. These concerns in our view were overdone, and since then customers have actually been upgrading their spend. NEXTDC has significant available capacity in Australia and a strong pipeline of projects for which we expect there to be strong leasing outcomes for as demand continues to grow. Over the period, we've also added to positions in CSL and ResMed.
As Dave spoke about, both these stocks have suffered from concerns around U.S. healthcare policy and tariffs. We believe these concerns are overdone, with both companies having strategies to navigate potential impacts, and we remain confident in their long-term earnings outlooks. Cyclical weakness in the Australian vehicles market and the U.S. housing market presented opportunities to add to our positions in ARB and James Hardie at attractive prices. Hardie experienced additional share price weakness as the market reacted to the price paid for the ASEC Apple acquisition. As the shares approached a level where we believe these concerns were overdone, we moved to add to our existing position, noting that the ASEC business has a strong market share opportunity and is strategically complementary to the business. We also added to our position in IDP during the period.
As Dave has discussed, this buying has since proven to have been too early, with the downturn resulting from synchronized international student policy tightening by governments around the world being more prolonged than we initially thought. We continue to evaluate our position and monitor policy settings, noting that management are focused on adjusting the cost base and taking market share as the industry faces these challenging conditions. As many of you will be aware, Mirrabooka Investments is our low cost, small and mid cap LIC managed by AFIC. Mirrabooka has a strong investment track record and in May announced the one for seven entitlement offerings which AFIC participated in. The capital raising was in response to a fall in the share prices of many companies during April in anticipation that opportunities would arrive to selectively add to stocks in the Mirrabooka portfolio on the bottom left box.
We also had one new portfolio addition during the period which was Telix Pharmaceuticals. Telix is a leading radiopharmaceutical company founded in Melbourne that operates in a very exciting and growing field of precision medicine. Compared to existing treatments, Telix's molecular targeted radiation technology offers more precise targeting of cancerous cells while also reducing damage to healthy surrounding tissue. Telix is a commercial stage company that is generating meaningful cash flow with products in market for prostate cancer diagnosis and a strong pipeline of late stage development products across kidney and brain cancers as well. We're attracted to Telix's strong commercialization capability demonstrated by the success of its drugs already in market as well as a strong pipeline of products over the medium to long term. The company has a strong founder led management team that has a proven track record in both drug development and commercialization.
We use the broad market sell off to build a small initial position in the stock at a level where we believe very little was being ascribed to the development pipeline. To capture these opportunities we've spoken about, we trimmed several holdings as highlighted in the top right box there, using share price strength to reduce positions where valuations appeared stretched. As Dave touched on, shares in Australia's leading bank CBA have reached a level where the valuation is extreme when weighed against the earnings prospects. We've also used share price strength over the last six months to trim positions in Wesfarmers, JB Hi-Fi, Telstra, Transurban, and Coles. We continue to view all of these companies as high quality and they remain core to the portfolio.
However, we view it as prudent to reduce their weightings at elevated levels with a view to add to the positions if and when valuations become more attractive for these stocks. There were no exits from the portfolio during the period. Moving on to the next couple of slides, I'll touch on a couple of our portfolio stocks and why we believe them to be good long-term investments for the AFIC portfolio as we usually do. Firstly, Transurban. Transurban is a leading owner and operator of toll road concessions in Australia and the U.S. The toll roads in Transurban's portfolio are unique and integral assets linking urban population centers and driving mobility and productivity in the economy. Because of the high-quality nature of these assets, the company benefits from inflation-linked tolls and strong traffic from economic and population growth.
As can be seen on the chart on the left, Transurban has had a strong track record of growing dividends since the GFC, disrupted only by COVID. Since COVID, traffic has been recovering and with a number of growth projects set to complete, we expect strong traffic growth to continue over the medium to long term. These factors should lead to ongoing growth in the dividend, playing an important role in the portfolio in providing income to support AFIC's own dividends to our shareholders. On Fisher & Paykel Healthcare on the next slide. Fisher & Paykel is a New Zealand-based company. It's grown over time to be a global leader in devices used for respiratory care, surgery, and sleep apnea in homes and hospitals globally. The company's ongoing investment in R&D has resulted in a very strong and innovative product suite.
As a result, Fisher & Paykel enjoys a strong market position that's difficult to dislodge once adopted by users. The company's strategy is focused on innovation and growing usage of its products in hospital and home settings. On this basis, we continue to see a long runway for earnings growth in the years ahead. The company has a very strong management team and board and maintains a net cash balance sheet primarily as a result of the strong cash flows generated by the business. With that, I'll pass back to Mark for an update on our international portfolio.
Thanks, Winston. As many of you are aware, we've got about 1.5% of the portfolio in a portfolio of international companies, and we've been building out a relatively small investment team to really apply the AFIC way of investing to global businesses. We initiated, I guess, real money into the portfolio in May 2021. It's just under AUD 170 million. We've got the performance numbers down below we've shown you, so three-year numbers. These are gross returns. The portfolio has been ahead of the index, and since inception it's about in line with the index. We think that's really credible performance given that we started out with a very small team covering that part of the market. We think they're solid numbers at this point and plenty for us to build on. We have been doing preparatory work on whether we can do another LIC.
That does take a bit of work to get to the point where we can be ready to launch a product if we want. There are still a number of things that we're sort of considering. Market timing is always really important on these issues, so we're just building up the ability to be ready to do that if we think the time's right.
So.
We still have great confidence in the process and how we're handling at this point. We still feel like there's good market demand for a low cost, no performance fee, low turnover international product. We think that's still very valid in this market, so we still feel comfortably building towards that. I think we still think that markets are becoming more global anyway. Many of our companies within AFIC are really global businesses. We are a little bit concerned that the Australian market is becoming a little bit narrower over time, so we still think it's an important part of the group to build out international capability, not just for the idea of launching a product, but just going from the point of view of our ongoing investments generally. That's where we sit at the moment.
We've done a lot of prep work, we continue to support the team running the portfolio, and we'll just keep watching for the appropriate next steps. Just pass to Geoff. Did you have anything you wanted to add to that at this point?
I think, Mark, I suppose the other issue we've got which has come up in the presentation is the discount our LICs are trading at the moment. That's clearly one of the issues we have to consider in terms.
Of launching anything in the future.
That's right. There are some of those factors still out there at the moment. The idea is to be ready if we get an appropriate opportunity and obviously keep looking to grow the product. As David Grace pointed out earlier, it's added value to the AFIC portfolio to be in such good company. It has made money for AFIC shareholders to be in this portfolio of very high quality companies. When I look through those great global businesses, the valuations in some instances are a lot more palatable than what you see in Australia. In a way, you're getting some very, very high quality companies at cheaper valuations than you see in the Australian market. All that comes together and says we should continue with the project. I'll pass back to David Grace for some outlook comments.
Thanks, Mark. We showed a chart earlier just outlining the price to earnings ratio for the ASX and how at current levels the market is trading approximately 20% above the long-term average. We've been surprised how resilient equity markets have been in recent months. Despite facing uncertainty on tariffs, government policy, global trade flows, and geopolitics, the market has kept pushing higher. On valuations, the market is polarized. Expensive stocks delivering strong earnings growth continue rallying higher, while companies facing near-term earnings pressure are struggling to find a buyer. While interest rate cuts may stimulate economic activity, the offset is companies are largely delaying investment and hiring decisions until the outlook becomes more certain. Share market strength, against this backdrop, feels fragile. However, opportunities are presenting where quality companies are temporarily being mispriced on negative short-term news. This is despite their long-term prospects being strong.
Recent buying in the portfolio of Telix Pharmaceuticals, Goodman Group, NEXTDC, ResMed, James Hardie, CSL, and Nanosonics are all examples of this in our view. We'll continue to focus our research effort on finding these opportunities when they emerge. At this point, I'll hand over to Geoff to coordinate Q& A.
Thanks, David. There are a few questions here on CBA. Will we look to, why not sell more shares now? Are we still thinking about selling CBA, and what is the average cost base of the shares we have in CBA? We won't answer that directly, but it's very low for a long time. David, over to you in terms of CBA selling.
Thanks for the question. We have sold a large amount of CBA during the last 12 months and, like every stock within the portfolio, the decision remains up for review. However, we do recognize that CBA is a very high quality business. It's run by a very strong management team and board that we rate highly, and it's consistently been able to deliver the highest ROE in the sector. For where it is at the moment, we feel the position size is appropriate, but obviously that's subject to change depending on how the share price trades from here.
This is a question for you, Andrew, which is sort of associated with the sale of the CBA. Do we think that providing such a large LIC tax deduction, attributable gain in 2025, 2026 dividend and possibly 2026, 2027
by selling more CBA, for example?
Could be used to assist with pushing.
The share price back towards NTA.
It's not the reason that we do it, but nonetheless it is an attractive feature of the LIC structure. Part of our marketing I think will be to point out to those parties that can make use of that tax deduction that it is. There is something to consider. We shall see.
We already had some questions about it after the announcement. That'll be something we'll continue to highlight with investors. There's a question here about investing in Xero relative to Intuit. Intuit's an international company, but investing in Xero.
Rationale there.
Yeah. In the domestic portfolio we do have a holding in Xero, which is, for those unaware, the cloud-based accounting software that was started in New Zealand and has established a really strong presence in both the Australian and New Zealand markets. More recently, it's been in the UK, where it's now a more competitive market. Xero's been able to establish a really strong position there and has seen really strong earnings growth. The opportunity from here is just about to capture earlier stage entry into the U.S., and that's where they will come up against Intuit, who is the largest player in that market and has a very strong position.
We think that there's still a great opportunity for Xero to be able to grow earnings, and there's upside if they are able to become the clear number two player in the U.S., which is the area where they've just made a recent acquisition to be able to grow their presence in that market. We're watching that with interest. It's been a really good performer for the portfolio, and we do rate the management team highly and certainly believe their strategy is likely to be a successful one.
The question on IDP, why do we continue to hold it given the current investment outlook?
Great question and it's a question we ask ourselves very frequently. It's clearly been disappointing up until this stage. However, the key things that keep us interested in the holding is IDP, particularly in the student placement market, is the clear market leader in a market that has grown for many, many years. Only in more recent times you've seen that coordinated government policy in most of their key markets being a headwind to the stock. We don't think that that's going to be a long-term structural trend, that student migration is going to be permanently impaired. When that turns, it's really difficult to be able to determine. That's very much dependent on a change in government policy, which we've got no particular insight in.
I think the strategic nature of their asset, the strong position that they hold in the market, and in a market that we think will return to growth at some point in time, like we've seen in previous downturns, IDP comes out with larger market share and in fact a stronger position in the market. Expectation is that will be the same this time around.
Thanks, David. Question on sort of a longer term performance, what's sort of been the reason we've underperformed over sort of the three, five and sort of ten year periods?
Yeah, a couple of things on that. Clearly the one year performance, being as disappointing as it was, has weighed on the three to five year numbers. The second thing is just a reminder, those numbers are reported after tax, so the tax is only back into the performance when it's distributed to shareholders. We are carrying a significant reserve of Franking Credits that aren't actually in those reported numbers.
Question on the large miners, how do you see the relative value preference performance in BHP versus Rio Tinto and also Woolworths versus Coles?
Yes, in relation to BHP and Rio Tinto, we actually hold both within the portfolio and I guess the starting point on both of those companies is that they are really low cost on the cost curve. They are very much sort of the lowest cost producers in the commodities that they produce. The benefit of that is even during low points in commodity cycles, both are able to deliver meaningful cash flow and that supports the dividends that we pay out to shareholders. If we had a slight preference, it would be for BHP, and that's sort of been where we've been putting incremental capital in recent times.
Our thinking there is, even though we recognize that iron ore is more mature today than it has been over the last five to ten years, where we're close to reaching peak steel demand in China and new supply, particularly out of Africa, is coming into the market. We don't expect iron ore to fall off a cliff. Certainly the glory days are behind us. Our positive view on BHP is really in relation to the copper assets, where they own the largest reserves of copper in the world. We see as economies continue to rely on electricity for their energy needs, copper is going to become more scarce and in higher demand. We see there's a great opportunity for BHP to be able to generate significantly higher value from the copper assets that they own.
Questions?
Frank Tolls and Woolworths, Tollsworth.
Yeah.
We have both in the portfolio. We think long term we've had a higher position rather in Woolworths and we've really been believers in the strategy that they've executed over a long period of time. In more recent times, the change in CEO at Coles with Leah Weckert taking over as CEO, it really seems a more focused strategy. They don't have all the ancillary businesses that Woolworths has and we've seen the operations improve quite materially. That's led to a far improved earnings profile and more consistent margins coming through from Coles. We'd say at the moment that Coles has been operating better than what Woolworths has and there's a couple of those assets like New Zealand and Big W that have been weighing on Woolworths now for a period of time.
We watch with interest around what the new CEO and her strategy is around dealing with those and reshaping the portfolio going forward.
Thanks, David. Look, there's a number of questions here about the share price discount to NTA, which I think we've covered off in the presentation. There's a couple of specific, I guess, points to touch on. One question is about whether we ever consider converting to an ETF. Would this even be possible? I'll throw that to you, Andrew.
If we were to convert to an ETF, first of all that would be a trust structure, so you'd lose the benefits of being able to smooth dividends. You'd have to have pass-through costs. Secondly, once you convert from a company into a trust, it's not a scrip for scrip allocation, so everybody would have to pay capital gains on the conversion. Thirdly, there'd be additional costs because you'd need a responsible entity. At the moment, I don't think it's likely. I think the negatives would outweigh any benefits. Yeah.
We like the fixed capital structure.
Absolutely.
Closed ended ETFs due to NTA discounts as well.
That's right.
Question mark about international, there's a few questions here. Will we think about increasing allocation to international equities, and why don't we make it a much larger portion of the portfolio?
Yeah, look, there's lots of ways we could take international. I mean, obviously I touched on whether we do a separate LIC, but we keep a very open mind as to how we develop with this. Another thing we could do, we could just keep the holders within AFIC or we could make it larger over time if we think that's giving us more opportunities. I guess the first thing that I would think about whether we should add to it or not is really where the opportunity is. At the moment, as Dave showed, the level of markets, we're seeing very high valuations in the U.S. as well. Interestingly, the U.S. stock market has exhibited very strong Earnings Per Share growth over the last really 10 years plus, whereas Australia hasn't had the same level of earnings growth that the U.S. has.
I guess another disadvantage though, if you go into overseas, if we put more into international, it means we're going to be receiving less franked dividends. That will affect our dividend profile and we'll be getting more capital growth if they perform well. These are things we need to think about. The other thing is obviously the currency. When you're investing internationally, the currency is really important. If we saw a big sell-off in the U.S., given that's the bigger part of our exposure—so exposures in international split between the U.S. and Europe, more of it's in the U.S. at the moment—if you saw weakness in the U.S. market, then we had a movement in the currency. If the Aussie dollar got stronger, I mean, you'd have to have a look at it if we think it could add value.
When we're looking at investment, it's all about adding value and we're all about seeking out opportunities. If an opportunity is going to add value, we'd have to look at it. It's something we've touched on and looked at and we may do it, but we haven't made a decision on that. It's a possibility.
How much further are we prepared to reduce.
Your position in CBA, Wesfarmers, and JB Hi, Fi, given the valuations there, would you consider another special dividend?
Off the back of these sales?
Yeah, look, it's a balancing act because as we said, every time we sell one of these, we're reducing the dividend pays we received. It's not like we still think these are great companies and we don't want to paint ourselves in a corner and just get out of them all because we still want exposure to these businesses, so we feel like it's been prudent. There's just a lot of, I guess, market feel and judgment call in how much we do take out. We think we've taken an appropriate amount out. At this point, we'd probably be wary about taking a lot more out. Certainly, if we did do more, we are aware that the capital gains drags on our performance and we'd have to be strongly thinking about if we're going to do more. It's got to come back to shareholders through special dividends.
It is a poor decision and cognizant of the fact that we currently our Earnings Per Share are roughly $0.225. We pay $0.265 in ordinary dividends. Until such time as that gap narrows, we will have to continue to pay ordinary dividend out of realized gains in prior year reserves.
There's got to be something else to ensure invest in as well.
That's right.
Whilst we're on the topic of dividends, we've talked in the past about equalizing the half year and full year dividends over time. Is that still our intention?
Yeah, look, that's a preference to do that. Whenever we look at this, the board has the conversation about bias towards trying to get it through an interim. Where we are at this point, we find ourselves with a lot of special dividends, and that really comes at an assessment of the full year result. We did show in the previous chart that we are paying out a little bit more than our Earnings Per Share, and that will come into our thinking going forward.
Thanks, Mark.
On the theme of dividends and franking, given the Labor Party has indicated it may make changes to Franking Credits, what would you do to ensure that the value of shareholders is not lost?
Yeah, look, we think it's something we watch very, very closely because the franking credit system is really important for all of Australia, not just retirees. I think the franking credit system can be lost on how it actually works. The system was introduced, rightly so, to avoid double taxation and to get everyone back to their correct marginal tax rate. That means companies are really a vehicle for collecting tax on the way through, and then that gets equalized when individuals put in their own tax returns. All it does is get individuals back to their correct tax rate. It's a great system. It's also very supportive of encouraging individuals to invest in the share market and support Australian listed companies.
We've seen that when we look back through history, there are times when things are going wrong in the global economy and the ability to recapitalize companies is important. The franking system encourages investors to invest and support Australian companies. It's a good system in that regard. It encourages people to run a self managed super fund and not rely on the government. That's a good system. If we take away Franking Credits, it destroys a key component of people running self managed super funds. We think it's a great system to encourage people to have their own super, self managed superannuation. All these building blocks are supportive of this system, and if we take it out there are going to be significant consequences. Our role, we see, is to continue to educate politicians on how important the overall system is, not just single components of it.
When this last became an issue, we went very public and I went, sat in an inquiry and got grilled over it and explained how all these factors are important. Luckily, it did become an election issue, particularly in Queensland, surprisingly, where there's so many retirees, and ultimately we think seats were lost because of the policy. We will certainly be there front and center if we think again Franking Credits are going to be threatened. We'll be very vocal on it. We'll go back to shareholders again as we normally do, to tell you to write to your local member, tell them that this is a big issue, and we certainly have seen the power of people behind this can have an impact. This is a constant live issue for us.
We'll certainly let shareholders know if we think there's something happening where they should start contacting the local member. Andrew, anything you wanted to add?
No, that's fair.
I mean obviously we will make the case both publicly and also privately to politicians and to their advisors, and would encourage, as you say, Mark, shareholders to do the same. It's not policy at the moment. We'll have to wait and see.
Yeah, that's right.
Thank you. Question for the investment team. Do we feel a major sell down by founders of Chemist Warehouse will provide an opportunity to buy more shares there?
Yeah, it definitely will provide liquidity where it hasn't necessarily traded in large volumes on a typical daily basis. The thing for us then is just to monitor exactly what price we're prepared to pay so that we can expect a good investment return from that price. We do have a small holding in Chemist Warehouse in the portfolio. We added some actually earlier this year and then we saw the stock run pretty hard sort of post that initial investment. We're just holding to our valuation discipline. Last time there was a sell down by the founders it was done at a very skinny discount. We just continue to monitor that.
If it gets to a level that we deem to be attractive, then absolutely it's a business we could see that we'd like to own a lot more of and it's clearly the dominant player within the pharmacy space, particularly in Australia, but also as it looks to broaden overseas. We see this as a fantastic long term opportunity, but very conscious around the price that we pay.
Question here about owning Mirrabooka and is it ethical to own Mirrabooka?
Is Mirrabooka a buy?
Another question here about why does it tend to trade relatively close to NTA whereas AFIC is trading at a discount?
Yeah, so obviously Mirrabooka Investments is another LIC that's listed that's managed by the investment team. It focuses on small to mid cap stocks. It's been around now 25 years, 26 now, 26 now. Sorry. Yep. Long track record of excellent performance. AFIC's a shareholder and AFIC, well, the directors make the decisions around the holdings in Mirrabooka Investments. The non-executives make those decisions about what to do with Mirrabooka Investments. When you stand back and look at it, it's been a great investment. I mean, we hold it simply because it's been a great investment for AFIC shareholders and it gives you exposure to that bottom end of the market. AFIC's AUD 10 billion fund, when you're getting to small caps, you really need to be taking a portfolio approach, have a spread of investments.
That's what Mirrabooka Investments does and that's the basis for investing and it actually, not only has it produced great performance, it's outperformed its benchmark, which is the combined mid cap and small cap index. It's comfortably outperformed the ASX 200, the broader market. You get a lot of that performance back as franked dividends. As I repeat, it's been a very good investment for AFIC shareholders. Now, Mirrabooka Investments recently did a capital raising and you were able to oversubscribe for stock and so AFIC did that because the price they did it was AUD 3.05. I think the current NTA that they published yesterday was around AUD 3.35, I think somewhere around that mark. At this point it appears to be good, AUD 3.39. There's no, because we're a cost recovery business, there's no conflict of interest because there's no fees paid based on the size of the fund.
Mirrabooka Investments simply took, they did their capital raising, they wanted to take as much up to the limit that they set. There was no benefit from AFIC going in it in any way, shape or form. There's no conflict, there's no conflict of interest, there's no conflict of interest at AFIC. The board of directors simply said is this a good investment at that price taking a long term view for shareholders and when you looked at the track record, I think that pretty comfortably came to the view that it looked like a pretty good investment. They took it up. Thanks, Mark.
Question here about how we use options. Is it about protecting the downside for companies like Westpac and CBA or for additional revenue?
Yeah, very much for additional revenue. We've got approximately 10% of the capital in what we call the B portfolio, which we are able to write options against. Typically, what we'll do is write call options for a three-month period. It's really just to boost the revenue. If a stock that we continue to like over the long term is temporarily looking mispriced, as in too fully priced, we'll look to write some call options to be able to boost the income. Ideally, we don't want to lose the stock, and we'll collect the option premium. It's just all additive to the income that we can generate on that investment.
I'm sort of coming towards the end of the questions here. I see the numbers are sort of going down, but a couple of questions about buybacks to reduce discount. What's the thinking around that?
I think we covered off that, but it's really being opportunistic. Another point as I touched on earlier is neutralizing the DRP if it's being done at a very low price. We make those decisions on an ongoing basis and it would generally be.
After the share trades activity.
Question here about an income producing LIC. Have we thought about that in the context of other ones that are available now?
We have Kiriwara Investments, which is an income fund. We look to produce a dividend yield at least 1 to 1.5% higher than what you get out of the market. It still gives you some market exposure. Gerry produces extra dividend primarily by selling call options. It does cap the upside a little bit. More recently, the income that you get out of Gerry has actually been much higher than 1 to 1.5% above the market. I just have a look at Gerry oris.
Jerry. Eduardo,
how are we integrating?
The evolution of AI into the investment strategy?
It's something that we are watching really closely, and it's obviously evolving very quickly. I guess in terms of the companies that we can invest into, we're really looking at how they're incorporating AI within their own business processes and whether or not it's just an investment that ultimately leads to greater efficiency that is just taking costs out of their business. The risk of that is just that everyone gets access to the same technology and that actually lowers the price that these companies can charge. I guess what we're looking for is companies that are able to use AI in some unique way or have some unique data that enables them to become more efficient while able to maintain their actual revenue profile, which should actually lead to a greater margin profile. It's something that we continue to watch very closely.
The obvious winners in that, it's a bit too early to tell who is going to clearly win. At the moment, our only exposure is really through the data center operators, where clearly there's more demand for their space that they're offering as a greater adoption of AI takes place. At the operating earnings level for most companies, that's something that we continue.
To watch from here.
I'll make this last question. There's a number of viewers going down quite dramatically now. A couple of linked questions, Mark. In terms of international, will we use ETFs to get exposure there, and what's the investment process around ETFs around the international portfolio?
No, we directly invest directly in the companies we really wanted to go by. Getting into international is use our processes and frameworks, which is about investing into individual stocks, not ETFs. We think ETFs is something that individuals can do themselves very easily. I'm not sure we can add a lot of value there. It's all about individual investing in the companies and using our experiences that we've built up to do that.
Thanks, Mark. Okay, there's a couple more questions. I can get back to people directly after the meeting. We'll finish there because there's fewer numbers going down quite dramatically. I'll pass back to you to close it.
Mark.
Okay, thanks Geoff. Thank you everyone for joining this call. Hopefully we've provided some good information insights to you. If you have follow up questions, you can always contact Geoff. The next point of contact will really be at the AGM in October. Thank you again for joining.
That does conclude today's conference. Thank you for your participation. You may now disconnect.